Third-party valuation is desirable in HPCL stake deal

We think that to transfer its 51% stake in HPCL to ONGC, Government of India (GoI) may have to well rely on third-party valuation rather than prevailing market capitalisation alone.

GoI’s stake transfer to ONGC is not akin to an OFS, whereby the latter would buy stock either through a block deal or an off-market transaction. (Reuters)

We think that to transfer its 51% stake in HPCL to ONGC, Government of India (GoI) may have to well rely on third-party valuation rather than prevailing market capitalisation alone. A decision otherwise will lead to GoI questioning its own agenda of improving transparency in governance and challenging the well-established doctrine, “Caesar’s wife must be above suspicion”. IBP divestment seems to be a great case study in the present context. Media, and subsequently investors, have been discussing intently the possibility of HPCL-ONGC merger or ONGC buying out GoI’s 51% stake in HPCL. The stock prices of all the three OMCs since the news flow on such possible realignment have been adversely affected despite strong dividend yields and inexpensive multiples.

As the merger between two oil companies will present challenges of integration and of minority shareholder approval, which mostly will not come through, the focus of the news flow is more on GoI transferring its stake to ONGC. Such a transfer of shareholding would allow GoI to mobilise $4.3 billion at CMP of HPCL. Media is also speculating that the mandatory open offer can be done away with it, as ultimately HPCL still a government-owned entity. Notwithstanding the scope of such an event, through this note we would like to highlight the following issues to the investors, who remain concerned.

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GoI’s stake transfer to ONGC is not akin to an OFS, whereby the latter would buy stock either through a block deal or an off-market transaction. Post the deal, GoI would actually give up its majority shareholding in HPCL, and would own it through ONGC. In simple terms, its effective holding in HPCL would lower to 35% from 51% at present. Prevailing market capitalisation (of HPCL) may not entirely be the basis for the aforesaid transaction, considering the ramification on valuation multiples of other oil PSUs. A third-party assessment of HPCL’s valuation may be relied upon to base the transaction, if at all it has to conclude, failing which GoI may leave scope for: 1) HPCL’s minority shareholders to question the basis of transaction; and 2) audit of such decision at a later date by authorities such as CAG.